There frequently seems to be confusion amongst business brokers, business buyers, and business sellers about which measurement of cash flow to use when valuing a business. This is, in fact, a very tricky subject and the answer depends on the valuation approach being utilized, and the assumptions used.

One common mistake I see is when people utilize a Discounted Cash Flow (DCF) approach. In a DCF approach you project the likely future cash flow of the business and then discount it back to the present at a rate that is commensurate with the risk of the investment. The theory is that the value of a business should be equal to the present value of all future cash flow. But what does "cash flow" mean? Is it Net Income, Earnings Before Interest Taxes Depreciation and Amortization (EBITDA), Seller Discretionary Cash Flow? Unless adjusting other assumptions a Discounted Cash Flow approach should use Operating Free Cash Flow (OFCF), which is EBITDA minus taxes and capital expenditures and adjusted for changes in net working capital (if the net working capital from the beginning of the year to the end of the year increases, then that would result in a decrease in OFCF).

What some people will notice is that OFCF is cash flow that is before paying interest expense. Yet, isn't interest a real expense? Why isn't that included when using a DCF approach? The reason is that interest expense is already taken into consideration in the discount rate.

The discount rate should be the Weighted Average Cost of Capital (WACC). So, for example, if a business was worth $10 million, and $5 million of equity capital was going to be used, $5 million of debt capital, and the expected return on equity by investors was 20%, and the after tax cost of debt was 5%, then the WACC would be 12.5% (i.e. 50% equity capital X 20% and 50% debt capital X 5%). Because the WACC already includes the interest as a cost of capital, it will naturally be taken into consideration when discounting the OFCF of the business. If you included interest as an expense in your projections then you would be double counting the cost of debt capital which would significantly and inappropriately lower the value of the business.

Regardless of whether you perceive it to be a positive or a negative, from a business selling perspective it has the unfortunate impact of creating uncertainty due to the complexity of the law. Complexity increases perceptions of risk which lowers perceptions of value and negatively impacts marketability. I'm sure that as people figure out the ins and outs of the law and compliance that this uncertainty will significantly decline, but for now it's not a positive when it comes to selling a business particularly for companies with more than 50 employees or who are close to having 50 employees.

You've decided to sell your business, and now need to determine when to tell employees. Should you do so immediately? When you start actively marketing the business? When you start meeting with prospective buyers? Only after a Letter of Intent has been signed? At closing?

Many business owners feel guilty and dishonest if they put a business up for sale and don't inform employees. There's the perception that an ethical person should not withhold this information from trusting employees. While every situation is different and merits consideration, as a business broker I've seen things go well and not so well in relation to timing of informing employees of an anticipated ownership change. Following are some thoughts to consider.

When you put a business on the market you don't really know whether or not it will sell. Yet if employees know a business is for sale, they may feel anxious and uncertain about the possibility of a new owner. If such an employee has considered working for someone else or if a recruiter calls them, the anticipation and uncertainty of the ownership change may cause them to go to work for a company they feel more confident about. If this happens, the loss of employees may make your business less marketable, and may reduce your odds of selling and achieving a good price and terms. If the business doesn't sell, you may have caused unnecessary disruption of your business. So, most often from a business broker's perspective telling employees that you are putting the business on the market is not a good idea. However, if you'd like to prepare employees for the possibility of a sale, there's nothing wrong with casually mentioning that you do want to exit the business sometime within the next 5 years. By giving employees a long window they won't be shocked when you do sell, but you also aren't creating the impression that change is imminent.

Some people worry that if they are actively marketing the business, employees will find out because lots of buyers will be visiting the business, particularly if the business is one in which visitors are not common. This is a very real concern, and it's why you need to be very careful about choosing a business broker or investment banker that uses a process that doesn't contribute to unnecessary business tours. When some business brokers get an inquiry from a buyer they will provide only limited information and then will strongly encourage a meeting with the seller and a visit to the business. This, unfortunately, wastes a lot of time for all involved and results in far more visitors to the business than necessary. In contrast, Codiligent business brokers has far more complete information packages that it provides to buyers and insists on ensuring that a buyer has a good basic understanding of the business and has asked appropriate follow-up questions before scheduling a visit. By doing more screening of such buyers it reduces the number of visitors. If employees ask about such visitors you can be honest without fully disclosing the nature of the visitor's intentions. For example, you can say the visitors are friends, investors, people analyzing the business, or people doing industry research. For the reasons previously mentioned, I would generally suggest not sharing that you are trying to sell the company at that point in time.

Another point in the deal cycle when it is tempting to tell employees is when the buyer and seller have agreed to a Letter of Intent. While this may seem logical given that both parties have conceptually agreed to major deal terms, the transaction still has to make it through formal due diligence, and the negotiation of the final purchase agreement. There are many things that can go wrong that will cause a deal to terminate during due diligence and purchase agreement negotiations. Consequently, generally this can also be a problematic time to make an announcement to employees. However, for some businesses it will be impossible for a buyer to complete due diligence without some of your employees providing assistance or information. A good investment banker or business broker can help you discern whether there are ways to obtain the information necessary for the buyer to complete due diligence without making an announcement and/or if it's possible to inform only a small group of key employees.

Most of the time, I've found it works best to wait to inform employees until a final purchase agreement has been negotiated and there is a very limited amount of time between the announcement and the transaction closing. At that time, it will be important for the seller to not only make the announcement and positively promote the buyer, but also for the buyer to have an opportunity to immediately interact with employees and present their positive vision for the company. If there is a good cultural match between the buyer and seller, and employees don't have time to worry about the uncertainty associated with a change, there will be far fewer issues and higher retention of staff. By Eric Williams

Will you or your kids be enjoying Cadbury eggs this Easter weekend? If so, have you ever wondered how they are made? Here's a peak inside the Cadbury factory where 47 million of these delicious treats are manufactured for only a couple of months a year. I'm always fascinated by the level of automation in modern factories - and this one doesn't disappoint.

A business is really just a collection of systems, assets, and people that are coordinated to work together to create and deliver products and services. It’s fairly common for small and lower mid-market businesses not to have written systems, where people simply know how to do things, with the only written policies and procedures being those associated with legal compliance and employment. However, businesses that have written policies and procedures for all aspects of their business, including detailed instructions of how to do specific employee tasks and jobs, will generally find that their businesses are significantly more marketable and potentially more valuable. A buyer will be more confident of a smooth transition and the ability to continue to successfully operate the business if they know there are detailed procedures for all aspects of running the business. If your business doesn’t have detailed written policies and procedures, it may seem like a daunting task to create them. Enlisting employees to document their particular jobs and tasks will make this far more manageable. Not having detailed written policies and procedures is one of the biggest missed opportunities for potentially increasing the value and marketability of a business. Doing this may also help you achieve better terms while not requiring as much time for due diligence, training, and transition. A few books that may be helpful for creating better systems include: “E-Myth Mastery” by Michael Gerber, “Work The System” by Sam Carpenter, and “The Toyota Way” by Jeffrey Liker. See below:

Here we are once again - it's April 15th - tax day. The day when the lines at the post office extend out the door, and those who have done well financially have a bit of a grimace.

It's past time that the tax code be simplified. According to an article in The Washington Post this week, the average small business owner devotes over 40 hours of time to compiling and dealing with tax return filing, and 25% of them spend at least three full weeks on this chore. Yet, this isn't because most business owners are trying to do their own taxes - no, the reality is that only 12% of employers filed taxes on their own without the help of a preparer or CPA. The tax code is simply too complex for most prudent business owners to take on the risk on non-compliance. Half of business owners spend more than $5,000 for expert help, and 25% spend more than $10,000.

So, assume that a small business owner had earnings of $250,000. At that size of a business there isn't likely an accounting staff and the owner would be the person responsible for devoting a week of their time to preparing tax information for their CPA. If you divide $250,000 by 51 weeks in a year (since the 52nd week is consumed by this compliance activity), that equates to a rough estimate of cost for the owner's time of $4,900. If you then throw in a CPA's bill of $5,000, this, in effect, is an additional hidden tax of nearly $10,000, or nearly another half a percent.

Then when you look at the high level of government administration required for such a complex tax system, it's no surprise that there are nearly 100,000 people working for the IRS, with an annual budget of about $12 billion.

There are many interesting tax reform proposals out there from a simple flat tax to a national sales tax. Please consider contacting your elected officials and insisting that they devote serious attention to tax reform and simplification.

Are you passionate about what you do as an entrepreneur? If not, Steve Jobs suggests that your business may not survive long term. If you've lost your passion, perhaps it's time to call a business broker or investment banker and explore a sale.

It may go without saying that a business where an owner works fewer hours to produce the same level of profit is going to tend to be both more marketable and valuable. Who doesn’t want to work less and make the same amount of money or more? However, as a business broker I see that most small and lower mid-market business owners work long hours, so if you are the rare exception who works limited hours, some business buyers will be skeptical of that claim, and will wonder “does the business owner really only work 10 hours per week, or is it closer to 40?”

Here are three suggestions of ways to help support a claim or working limited hours:

Don't hang around at the business when you aren't working. It's not unusual for a business owner that doesn't have to work much in their business to still go to their office and spend part of the day dealing with other business and personal interests. Perhaps they spend an hour a day talking on the phone to family and friends, read the paper for 45 minutes, spend time looking for real estate investments, monitor a personal stock portfolio, etc. The problem with doing all of these activities at the office within a year or two of selling is that while you know that you are only working 10 hours a week, your employees, vendors, and customers see you at the business in what appears to be a full-time capacity. So, during due diligence when a buyer starts trying to verify your claim that you only work 10 hours a week, they will find that others see you there "all the time". From a business broker's perspective, if you work limited hours, my suggestion would be that 12-24 months in advance of when you want to start marketing your business, that you be very disciplined about only being at your business when you are doing work related to the business.

Create a work journal. It may make sense to create a work journal starting 6 months to a year before you are ready to engage a business broker to sell your company. If you keep diligent daily records of the time you work and the tasks you do while you are working, it will help provide proof of your limited working hours. Sure, it's a bit of a hassle, but if you are truly working limited hours, it shouldn't take that much extra effort. There are smart phone billing apps that could be used to easily track your time. It’s important that this be accurate so that you won’t face assertions of mis-representation if, after a buyer acquires your business they find themselves working 40 hours per week rather than 10 hours as represented, while doing the same basic tasks.

Take one or two 3-4 week vacations the year before you are going to sell.One good way to prove that your business can run well with more limited active owner involvement is to take one or two 3-4 week vacations without working while you are out of town. If you and your business broker can document your extended vacations and show that there was continued good performance despite your absence, it will give a prospective buyer confidence that they will be able to step into a business that is operationally sound where they can focus more on strategic initiatives.

If you are on the other end of the spectrum, where you are working very long-hours in your business, it can negatively impact both marketability and value. If you are working more than 50 hours a week, on average, you may want to consider creating better systems, cross-training staff, delegating more work, and/or hiring more people to help you manage your work load down to less than 50 hours a week.

Does your business tend to have one-time customers, repeat business, or recurring business?

I was talking with a business owner the other day and he indicated that a large percentage of his business is recurring. When I talked with him further I learned that he, in fact, had repeat business not recurring business - and this is a very important distinction that I thought may be of interest to others.

Repeat business is when a customer returns and transacts business, but there is no real predictability to when they will be back or the amount that they will spend. For example, if I take my car to a certain car wash they may know that I'm a repeat customer - I may visit them roughly once every two weeks. However, they have no idea when I'm going to come for certain, whether I'll do a full wash and vacuum or just a wash, or even whether I'll ever come back and transact business with them again.

Recurring business is when a customer buys the same product or service at pre-set intervals and will continue buying that same product or service on schedule until cancelled. An example of this would be a Netflix subscription. Every month at exactly the same time Netflix customers' credit cards are charged, and in return, get access to the company's on-line downloadable movie and TV show collection.

Because of the high level of predictability of revenue, recurring sales businesses tend to be far more attractive to business buyers than repeat or one-time sales business models. If you have a business that has either repeat business or one-time sales there are ways you can create a recurring revenue model that will make your business more attractive to a business buyer.

A few ideas on how this can be achieved:

Maintenance contracts. If you sell products or services that may require maintenance, perhaps consider selling a monthly recurring maintenance or service contract rather than relying on repeat business when the client needs service.

Lease, rent, or license rather than ownership. For some businesses having a contract for use rather than selling an item, may help lock in the customer longer-term while also producing a predictable monthly revenue stream.

Different business model and value proposition. If you are a customer under a traditional HMO or PPO type of health insurance program you may wait until you are sick to see a doctor (other than check-ups) and then once you see the doctor, the doctors bills your insurance. Have you heard of concierge medicine? Some primary care physicians have become tired of dealing with insurance company reimbursement, unpredictability of income, and administration of a complex billing system. So they developed concierge care, where a doctor will take on only a limited number of clients - but in exchange the clients pay the doctor a monthly or annual membership fee. For general primary care issues, the doctor can take care of them. If a specialist is required, the primary care concierge doctor will help their client source and screen the right specialist, and help ensure that their client is receiving and understand the care received from the specialist. The concierge client needs insurance to pay for the specialist, but because they are paying a subscription to the concierge doctor for primary care, they can be comfortable with a high deductible insurance plan. Perhaps there are similar tweaks to traditional business models that could be made in your industry.

For some businesses it may not be possible to set up a recurring revenue business model. Likewise, going from a repeat to recurring business model may not be practical. To the extent that a recurring revenue model can be established, though, it will be an attractive marketability factor when it's time to sell your business.